On April 9, 2021, the SEC’s Division of Examinations (“EXAMS”) published a Risk Alert summarizing its observations from recent examinations of investment advisers, registered investment companies, and private funds engaged in ESG investing. The Risk Alert is the latest in a series of announcements from the regulator that demonstrate its focus on investor protection in connection with climate and ESG investing.
According to the SEC, investment advisers and funds have expanded their various approaches to ESG investing and increased the number of product offerings across multiple asset classes due to increasing investor demand. This rapid growth in demand, increasing number of ESG products and services, and lack of standardized and precise ESG definitions present certain risks.
Exam Focus Areas
ESG firms subject to SEC examination should expect the following to be key areas of focus for examiners:
Examinations will include a review of the firm’s policies, procedures, and practices related to ESG and its use of ESG-related terminology; due diligence and other processes for selecting, investing in, and monitoring investments in view of the firm’s disclosed ESG investing approaches; and whether proxy voting decision making processes are consistent with ESG disclosures and marketing materials.
Performance Advertising and Marketing
Examinations will include a review of the firm’s regulatory filings; websites; reports to sponsors of global ESG frameworks, to the extent the firm has communicated to clients and potential clients a commitment to follow such frameworks; 6 client presentations; and responses to due diligence questionnaires, requests for proposals, and client/investor-facing documents, including marketing materials.
Examinations will include a review of the firm’s written policies and procedures and their implementation, compliance oversight, and review of ESG investing practices and disclosures.
SEC staff additionally observed several instances of potentially misleading statements regarding ESG investing regarding:
– Portfolio management practices were inconsistent with disclosures about ESG approaches,
– Controls were inadequate to maintain, monitor, and update clients’ ESG-related investing guidelines, mandates, and restrictions,
– Proxy voting may have been inconsistent with advisers’ stated approaches,
– Unsubstantiated or otherwise potentially misleading claims regarding ESG approaches. For example, marketing materials for some ESG-oriented funds that touted favorable risk, return, and correlation metrics related to ESG investing without disclosing material facts regarding the significant expense reimbursement they received from the fund-sponsor, which inflated returns for those ESG-oriented funds,
– Controls to ensure that ESG-related disclosures and marketing are consistent with the firm’s practices,
– Compliance programs that did not address adherence to global ESG frameworks to which the firms claimed to be adhering.
The staff also observed that compliance programs were less effective when compliance personnel had limited knowledge of relevant ESG-investment analyses or oversight over ESG-related disclosures and marketing decisions. For example, compliance controls and oversight for reporting to sponsors of global ESG frameworks and responses to requests for proposals and due diligence questionnaires appeared to be ineffective.